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NEWSLETTERS & ALERTS
Keeping Up with the Joneses – But Failing to Anticipate the Risks
by Howard Haykin
Edward Jones & Co agreed to pay a $725K fine to settle FINRA charges that it failed to establish, maintain and enforce an adequate supervisory system, including written procedures, concerning the creation and dissemination of consolidated reports.
BACKGROUND. Edward Jones is based in St. Louis, MO, and has been a FINRA member since 1939. It is a nationwide broker-dealer with more than 17,000 registered persons operating in over 12,000 branch offices. The firm has no relevant disciplinary history.
FINRA FINDINGS. From April 2010 through 2014 (the "Relevant Period"), the Firm offered 2 centralized and automated tools that registered reps used to create reports that, among other things, present comprehensive financial information to customers about assets held at the Firm, as well as assets held away from the Firm. For assets held away from the Firm, the registered reps would manually input information based on facts provided by the customer. The reports were generally provided to customers during in person planning meetings, though on occasion, they were made available through online account access or were mailed to customers.
During the Relevant Period, the reports contained disclosures stating the reports are not account statements and should not be relied upon as account statements. Additional disclosures throughout the Relevant Period included statements such as that the document "was created as a courtesy and it may include information about assets that are not held at or may not have been verified by Edward Jones" and that “Edward Jones assumes no responsibility for vendor and client assets held outside of Edward Jones or for the accuracy of the data relating to those assets."
A "consolidated report" as defined by FINRA Regulatory Notice 10-19 is a document provided by a broker to a customer that combines account information regarding a customer's financial holdings, regardless of where those assets are held. Consolidated reports supplement, but do not replace, the customer account statements required pursuant to NASD Rule 2340.
Regulatory Notice 10-19 reminds member firms that consolidated reports are communications with the public and therefore must be clear, accurate, and not misleading. Firms that allow reps to create consolidated reports must supervise the activity. Where consolidated reports include accounts and assets held away from a firm, the firm must ensure that registered reps are taking reasonable steps to ensure that those accounts and assets are valued accurately. The Notice recommends that firms providing consolidated reports to customers ''ensure that the size and complexity of the consolidated reporting program does not exceed the firm's ability to supervise the activity and to subject it to a rigorous system of internal controls."
What Went Wrong? During the Relevant Period, approximately 52 million reports were generated by the Firm's registered reps. However, the Firm had no reasonably designed system or procedures in place to mitigate risks described in RegNote 10-19, nor did it have in place a centralized review process. For example, …
- Edward Jones had no policies or procedures to guide registered reps regarding the creation and use of the reports.
- Edward Jones had no guidance for how registered reps should include outside asset information in the reports.
- Edward Jones had no guidance for whether steps should be taken to verify that information before it was included.
- Edward Jones had no procedures or guidance for updating the outside information included in the reports – e.g., how often, and with what source materials.
- Edward Jones had no ability to determine whether the reports generated by the reps were actually delivered to customers.
- An unintentional vendor-created design flaw enabled registered reps to manually edit assets held at the Firm.
- Reports generated by one tool (but not the other) identified whether assets were held at the Firm, by a vendor, or away from the Firm.
Mitigating Factors. A retrospective review that sampled approximately 65,000 reports did not reveal any instances that were materially inaccurate or misleading. That said, the Firm undertook a comprehensive review of the creation and use of the reports and implemented extensive remedial changes. The enhancements to the Firm's system include: (i) a risk-based review of the reports; (ii) enhanced disclosures; (iii) new procedures and mechanisms for verifying outside assets; and surveillance that detects gaps in information between the reports and the Firm's outside business activity database.
FINANCIALISH TAKE AWAYS. Before introducing new products or services, firms must try and identify attendant risks – i.e., what can go wrong? – and follow that assessment by developing enhanced policies and controls. The methodology is akin to updating a firm’s Written Supervisory Procedures (WSPs) for new and revised rules and regulations.
This case was reported in FINRA Disciplinary Actions for September 2017.
For details on this case, go to ... FINRA Disciplinary Actions Online, and refer to Case #2016049783001.